IFRS 4 Phase II Examples for Short Term Insurance Karl Meissner-Roloff November 2014 Discussion points • Areas considered / Scope • Valuation Method - considerations in application • Product based examples • Concluding remarks Disclaimer Contents of this presentation represent my own views and not that of my employer. Areas considered in this presentation represent on a portion of the changes required under IFRS4 Phase II and should therefore not be taken as an exhaustive demonstration of all requirements. Scope / Approach • Consideration of a few typical Short Term (ST) insurance contracts • Simple examples used to illustrate points – does not cover all eventualities • Identify some of the considerations / pitfalls in switching from existing practice to IFRS4 Phase II • Not going to go into details of OCI – but something that can be used for ST insurers Valuation Method Building Block Approach (BBA) Principles Block 3: The unearned profit the insurer Contractual Service Margin expects to earn as it fulfils the contract • Current The amount between a Block 2: certain and an • Represent fulfilment of obligations Risk Adjustment uncertain liability under the contract • Discounting Amounts the insurer expects to collect from premiums and pay out as it • Risk adjustment Block 1: acquires, services and settles the contract Present Value of Best Estimate Use a discount rate to • Contractual service margin Fulfilment Cashflows adjust the cash flows for the time value of money Valuation Method Premium Allocation Approach (PAA) • What is it? Approach which is very similar to current 365ths method for UPP • When can it be used? “Practical Expedient” for cases where: – Term less than 1 year (and thus also no discounting) – Results would resemble Building Block Approach • Where can it be used? Only for ‘unearned’ portion of premium Example 1 Monthly Policy – e.g. Motor IFRS / Current IFRS 4 Phase II Contractual UPP IBNR + OCR Service Margin Risk Risk SAM Adjustment Adjustment Premium Claims Cashflows Cashflows Provision Provision Future Exposure Incurred Claims Example 1 Monthly Policy – e.g. Motor IFRS / Current IFRS 4 Phase II UPP IBNR + OCR Premium Risk SAM Allocation Adjustment Approach Premium Claims Cashflows Provision Provision Future Exposure Incurred Claims ‘Unearned Premium’ Monthly Policy IMPACT: Minimal IFRS / Current IFRS 4 Phase II UPP Premium SAM Allocation Considerations: Approach Premium • Almost same as UPP profile over time Provision • ‘Implicitly allow’ for acquisition cost • Given small size of amount, likely not worth effort of performing BBA • Contract boundary similar to SAM – based on coverage period, but also up to point where policy can be re-priced Incurred Claims Monthly Policy IFRS / Current IFRS 4 IMPACT: Moderate Phase II IBNR + OCR Risk Adjustment Considerations: SAM • Best estimate cash flows – almost the Claims Cashflows same although no allowance for Provision overhead expenses / ULAE • Risk Margin: – Could use percentile from reserve distribution – Alternatively use cost of capital approach, HOWEVER: wont be same amount as SAM: – SAM Risk margin based on 6% cost of capital, and depending on approach might differ (calculated per line of business, after diversification). – NB: As part of disclosures will have to indicate implied level of confidence Example 2 Annual Policy IMPACT: Minimal / Moderate Contractual Service Margin Incurred claims: • Treated similar to monthly policies Risk PremiumRisk • If run-off longer than 12 months, AdjustmentAllocation Adjustment discounting will likely be required Approach • Disclosures include yield curve used for discounting Cashflows Cashflows Future Exposure: Future Exposure Incurred Claims • PAA still most practical Example 3 Motor Monthly Policy + CASH BACK • Still some uncertainty around where Contractual exactly cash back will be accounted Service Margin for Risk PremiumRisk • Latest from IASB seems to indicate: AdjustmentAllocation Adjustment – Need to accrue for future cash back – similar to Approach claims beyond coverage period / risks attaching – Seems likely to be accrued under Incurred Cashflows claims Cashflows – Actuarial estimate to be used (claim, lapse decrements, etc.) *** • Definition of cash back to be considered Future Exposure Incurred Claims carefully – must be ‘insurance liability’ *** to be confirmed – not in line with current exposure draft Other Key Consideration • If reward / cash back is certain: – Seen as non-distinct investment component - split out from insurance revenue • I have SAM BE cash flows and risk margin – why not use BBA? – Maintenance of CSM over time is not a trivial task – adds complexity – Level at which calculation done becomes more important – Need to allocate risk margin between future exposure and incurred claims – wont be a straight forward calculation from SAM risk margin Concluding remarks • Changes are not as significant for Short Term as it is for Life, but Devil is in the detail. • Selection of methodology has further implications – disclosure, tracking of historical calculations • Consider Income Statement impact of guaranteed rewards • Worth it to start early with implementation: – Early adoption likely to be allowed in transition period – ED largely finalised for short term contracts Questions.